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THE IMPACT OF CONSERVATISM TO EARNINGS QUALITY OF LISTED MANUFACTURING COMPANY IN INDONESIA
Melisa Stefani Dewi Ratnaningsih
International Financial Accounting Program, Faculty of Economics, Universitas Atma Jaya Yogyakarta
Jalan Babarsari 43-44, Yogyakarta ABSTRACT
This study aimed to investigate the impact of conservatism to the quality of earnings information. Conservatism is one of accounting topic that become an important issue, as its
impact to accounting fieldwork can be positive and negative. While earnings information is crucial information needed for the users to make economic decision. Samples in this study
are listed manufacturing companies in Indonesia. Conservatism is the independent variable. Earnings quality as dependent variable will be represented by earnings management.
The result of this study show positive impact of conservatism to earnings quality. Conservatism is proven to increase earnings quality by decreasing the level of earnings
management in the company. The result of this study complement previous studies findings.
Key words: Conservatism; Earnings Quality; Earnings Management; Market to Book Value; Discretionary Accruals
I. Introduction
A.
Background
One of components in financial statement is earnings. Earnings can be considered as the most important information in financial statement to make investment decision. From
earnings number, investors do not only get the insight about company performance but also its ability to pay dividend. A company needs to have sustainable growing earnings to
attract investors. Sustainable and growing earnings mean the company will be profitable in the future and able to continuously pay dividend, while company with small and
unsustainable earnings may less profitable in the future. The latter tend to be less attractive in investors point of view. Hence, management will carefully present earnings
and try to make earnings more appealing.
Appealing earnings, however, does not always show good earnings quality. Many practices can be used by management to provide appealing earnings. Most of them,
although not all, can reduce the quality of information present in financial statement. Earnings information could be manipulated due to the advantage held by manager over
investor. Manager has more information about company’s condition compare to investor as outside party who does not involve in company activity. This information asymmetry
will give opportunity to manager to perform earnings manipulation. Hence, appealing earnings reported by manager have high possibility to be manipulated.
Francis et al. 2006 stated that good earnings quality is earnings information that precisely reflect the real condition of company and contain less uncertainty. As mention
earlier, good earnings number or appealing earnings does not always same with good earnings quality. Earnings information that reflects the real condition of company can
show bad earnings number and poor company’s performance. On the other hand, high earnings number resulted from manipulation practices by manager show poor earnings
quality, as it does not reflect the real condition of the company.
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Criteria for good earnings quality also mention in Dechow et al. 2010 and Schipper and Vincent 2003, as they defined earnings quality as the quality that earnings should
have to make it useful for decision making. If earnings cannot provide information that can be used to make decision, then it can be said as poor earnings quality. Srinidhi et al.
2011, Bellovary et al. 2005, and Li 2011 stated that good earnings quality means that current period earnings can be used as benchmark to predict future earnings. In other
words, earnings information will not significantly change from time to time. Hence, we can say good earnings quality can be achieve if the information useful to make decision,
which is to predict the future earnings.
This study follows the view that good earnings quality is earnings information which contains no manipulation practice. The act of earnings manipulation by managers or
earning management will result in misleading information. This type of information will not be able to fulfill the objective of financial statement which is provides information
that assist its user to make decision. To limit the practice of earnings management, company can use prudence or conservatism. Conservatism is one principle that able to
reduce manager’s opportunity to do earnings management. Eventually, it will lead to the achievement of good earnings quality.
Prudence as mention earlier, it is one component of qualitative characteristic that require higher degree of caution in presenting information when uncertainty occur.
Conservatism also can be means as the action to choose decision that will less not overstating income and assets when dealing with uncertainty condition. Conservatism
from Kimmel et al. 1998 and Marshal et al. 2002 point view is the principle used by accountant to make judgment and estimates that will result in lower profits and asset
valuation estimates. Conservatism principle contradicts with earnings management as it does not allowed manager to overstate earnings number to get certain amount of bonus or
incentives. Hence, conservatism practice in the company can reduce the level of earnings management.
This study supports the view of conservatism role in reducing earnings management practice. The low level of earnings management results in higher earnings quality, as
earnings in formation reflect company’s real condition. Previous studies result shows that
applying conservatism result in lower earnings management level. As mention by Watts 2003, LaFond and Watts 2008, and Haniati and Fitriany 2010 conservatism reduce
the man ipulation practices by management as its limit manager’s opportunity to overstate
assets and earnings number. Moreover, conservatism principle also requires manager to use higher degree of caution when dealing with uncertainty. Hence, it can be said that
conservatism lead to more precise presentation of earnings information and less uncertainty earnings information which mean good earnings quality.
Although many studies and literature mention about positive impact of conservatism, other studies found bad impact of conservatism. In Indonesia, many studies attempt to
find the impact of conservatism practices to company and investors, such as Widya 2004, Haniati and Fitriany 2010, Oktomegah 2012 and Sari 2014. The result are
varies and sometimes contradict one another. Some of researchers find positive impact and some other find the opposite. Nevertheless, it still becomes one topic that attracts
researchers in Indonesia and other countries around the world due to its controversial relation with accounting standard setter and its diverse result in previous studies.
Moreover, Widya 2004 found more than 50 companies in Indonesia are proven apply conservatism. This study will help investor to get deeper insight on the impact of their
choice to implement conservatism principle. Hence, this study is worthy to be done and its result can give idea about conservatism to investor, company, and standard setter.
B. Research Problem
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Does conservatism give impact to earnings quality of listed companies in Indonesia?
C. Research Objective
This study will provide the answer along with empirical evidence whether conservatism gives impact to earnings quality of listed companies in Indonesia.
II. Theoretical Background and Hypothesis Development
